1 Party media’s spotlighting of ‘cognitive misconceptions’ about economic policy underscores Beijing’s lack of rescue means
Study Times, a Party media under the CCP Central Party School, published a piece on Aug. 16 titled, “Clearing Up Eight Cognitive Misconceptions About Expanding Domestic Demand” (釐清擴大內需的八個認知誤區).
The eight “cognitive misconceptions” are:
1. “Solely relying on investment or consumption to boost the economy”
- The article argues that the increase in consumption capacity and the expansion of consumption demand depend to a certain extent on the expansion of investment and is the result of investment. Only by effectively combining investment and consumption can the strategy of expanding domestic demand be realized.
2. “Too much investment, too low consumption”
- The article argues that how much investment there is depends crucially on the objectives and tasks of development, as well as resource conditions and macroeconomic operating conditions, rather than on simple country-specific analogies. Expanding investment is in fact a prerequisite and foundation for expanding consumer demand and improving people’s living standards.
3. “Investment inefficiencies”
- The article acknowledges that the marginal output per unit of capital has been gradually declining in China, but does not believe that this represents an efficiency problem for Chinese investment per se. The article argues that investment efficiency in China is still high compared with other countries at the same stage of economic development.
4. “Excessive and wasteful infrastructure, and limited space”
- The article acknowledges that the bulk of the new infrastructure (constructed and being constructed) are industrial investments. Therefore, the article argues that there is a need to deal with the relationship between traditional infrastructure investment and new infrastructure investment.
5. “Government investment squeezes out private investment”
- The article acknowledges that government investment in China is dominated by investment in infrastructure construction, which “carries significant positive external effects.” Also, when “social investment has insufficient motivation and willingness,” government investment will not have a “crowding-out effect” but will instead produce “a compensating effect and a leading effect.”
6. “Split between residential and public consumption”
- The article acknowledges the necessity of promoting the actual consumption of individual residents on the one hand, as well as promoting individual consumption through public consumption, accelerating the construction of public services and infrastructure, improving the consumption environment, and unclogging consumption blockages on the other hand so as to enhance the willingness and ability of residents to consume.
7. “Cash handouts to promote consumption”
- The article noted that some countries have made direct cash handouts to stimulate consumer demand, but while the method “has a certain effect,” it is “simply too costly and not feasible in China.”
8. “No space for policy”
- The article argues that China still has “policy space” that it can tap to expand domestic demand. The article added that while there are indeed local debt structural problems in some parts of China, it does not constitute the “main contradictions and problems of the economy,” and “no growth or low growth is the biggest risk that China should prevent.” Also, there will be “no major debt risks” as long as debt financing enables economic recovery or increases the level of potential economic growth and strengthens the financial base.
Backdrop
1. Fu Linghui, a spokesman for the National Bureau of Statistics, said during a press conference on the national economy on Aug. 15 that there is “no deflation in China” and there will be no deflation in the future.
Fu also said that the CCP authorities would be suspending the release of data on youth employment as it looks to “optimize” collection methods. He said, “In recent years, the number of university students has continued to expand. The main responsibility of current students is studying. Society has different views on whether students looking for jobs before graduation should be included in labor force surveys and statistics.”
With regard to risks for property developers, Fu said that they could be gradually resolved through “policy optimization.”
2. Foreign investors are losing confidence in China due to heightened geopolitical pressures, visible signs of economic decline and Beijing’s seeming unwillingness to implement major stimulus, and the worsening real estate sector debt crisis and financial contagion.
- U.S.-based hedge funds have cut their exposure to China in the second quarter of 2023.
- The Financial Times reported on Aug. 17 that global investors almost completely reversed 54 billion yuan in net purchases of Chinese equities that came after the Politburo’s July 24 pledge to increase support, using calculations based on data from the Hong Kong Stock Connect. Figures from the PRC foreign exchange regulator also showed that bondholdings of foreign institutional investors fell by 37 billion yuan in July to 3.24 trillion yuan. The Times also reported portfolio managers and analysts as saying that the selling of Chinese equities “had gained pace in August and was likely to accelerate in the wake of a surprise cut to a benchmark interest rate.”
- Economists are revising their forecasts of China’s 2023 GDP growth to below 5 percent.
- Jens Eskelund, president of the European Union Chamber of Commerce, told South China Morning Post that EU businesses are still keen on China’s markets but are reluctant to bet on its sputtering economy. Eskelund said, “What we see now in the economy is a crisis of confidence,” adding that “insecurity about what the future would hold” has weakened business sentiment while weighing on the outlook for foreign-direct-investment (FDI) inflows in geopolitically troubling times. He also said, “From an FDI perspective, China is experiencing a perfect storm in which there are many factors now conspiring.”
Our take
1. Most of the eight “cognitive misconceptions” in the Study Times piece are suggestions and proposals by Chinese and foreign economists about how the CCP authorities should go about fixing the economy. The arguments against those “cognitive misconceptions” put forth by Study Times are heavy in vague Party-speak and essentially signal to those economists and CCP officials that the Xi leadership will stick to its current plan for economic rescue and will not accept anything that Beijing does not acknowledge.
On one level, Beijing’s refusal to accommodate ideas aside from its own reflects an ossification of the CCP regime’s decision-making process. This outcome is partly due to Xi Jinping’s preoccupation with maintaining political power, and partly due to his need to navigate the systemic deficiencies of the CCP authoritarian dictatorship to ensure that his orders are duly implemented by the officialdom (the “orders not leaving Zhongnanhai” problem).
2. CCP leaderships since the time of Mao Zedong have never admitted governance and policy failures as they strive to maintain the Party and the Party head’s “great, glorious, and correct” (偉光正) image. If anything, CCP leaderships past and present tend to “spin tragedy into victory” (喪事當喜事報) to cover up disastrous political campaigns such as the “Great Leap Forward” and “zero-COVID.”
CCP leaderships do admit failures and mistakes when publicly acknowledging less damaging facts to cover up more damaging developments (i.e. admitting to “organs from executed prisoners” to obscure and distract from allegations of live organ harvesting from prisoners of conscience) and when publicly ousting factional rivals (i.e. admitting that the Cultural Revolution was a “decade of catastrophes” in purging the “Gang of Four”). However, such occasions are few and far between, and CCP leaderships generally avoid calling attention to matters that suck away so-called “positive energy” (正能量) generated by its propaganda.
Given the political tradition and environment in the PRC, the Xi leadership cannot simply adopt the various economic rescue suggestions offered by domestic and foreign experts. To do so would be to partially admit that Xi’s policies and governance have failed, and such self-undermining of “quan wei” (authority and prestige) is tantamount to political suicide for Xi. Therefore, Beijing has to keep packaging Xi Jinping’s economic solutions, or lack thereof, as so-called “high-quality development,” “stable recovery,” “policy optimization,” as well as fabricate data or not publish them at all.
3. The Xi leadership’s inability to be more flexible on policy, however, is also political suicide of another sort for Xi Jinping at a time when the CCP regime is plagued by serious internal and external crises. If the officials responsible for formulating policy cannot make recommendations that are potentially more effective in addressing certain problems but will end up refuting Xi’s past policies, then Beijing is essentially paralyzed on the governance front.
Meanwhile, local officials are incentivized to echo the Xi leadership’s slogans and pay lip service to Beijing’s policies so that they remain “politically correct” and can safeguard their personal interests in the high-pressure political environment created by Xi Jinping. Put another way, officials are prone to “inaction” (不作爲) and local governance will be paralyzed as no one dares to implement sensible and situation-specific economic policies to turn things around in communities across China. Ultimately, ossification in the decision-making process leads to ossification of governance in the CCP regime at large, with the Xi leadership being saddled with the final blame for problems that arise from governmental paralysis at all levels.
Should current trends hold, Xi and the CCP’s “Gray Rhino” economic risks could eventually metastasize and result in political “Black Swans” for the regime.
2 Financial contagion spreads from property sector to shadow banks, local gov’ts
Property sector crisis expands
Aug. 15 – Aug. 16
The PRC National Bureau of Statistics released the following real estate data for July:
New commercial housing sales price (in 70 major cities)
- Prices in first-tier cities remained flat for the second consecutive month in July. With regard to specific cities, prices in Beijing and Shanghai rose month-on-month by 0.4 percent and 0.2 percent respectively, while prices in Guangzhou and Shenzhen decreased month-on-month by 0.2 percent and 0.6 percent respectively.
- Prices in second-tier cities fell by 0.2 percent month-on-month in July, compared to no change from May to June.
- Prices in third-tier cities fell by 0.3 percent month-on-month in July, with the rate of decline expanding by 0.2 percent from the previous month (down 0.1 percent in June).
- Just 11 of the 70 cities saw price increases on new commercial housing in July, down from 22 in June.
Second-hand commercial housing sales price
- Prices in first-tier cities fell month-on-month by 0.8 percent in July, with the rate of decline increasing by 0.1 percent from the previous month (down 0.7 percent in June).
- Prices in second-tier cities decreased month-on-month by 0.5 percent in July, with the rate of decline increasing by 0.1 percent from the previous month (down 0.4 percent in June).
- Prices in third-tier cities dropped by 0.4 percent month-on-month in July, with no change in the rate of decline from a month ago.
- Six of the 70 cities saw price increases on second-hand commercial housing in July, down from seven in June.
National real estate market
- From January to July 2023, total investment in real estate development declined by 8.5 percent (calculated on a comparable caliber) from a year ago to 6.7717 trillion yuan, or seven consecutive months of negative growth. Residential investment fell by 7.6 percent from a year ago to 5.1485 trillion yuan.
- From January to July, the sales area of commercial housing fell by 6.5 percent to 665.63 million square meters, the lowest in seven consecutive months of negative growth; residential sales area fell 4.3 percent to 576.23 million square meters. Meanwhile, sales of commercial housing decreased 1.5 percent to 7.045 trillion yuan, lower than the growth rate in January (down 0.1 percent); residential sales increased by 0.7 percent to 6.3184 trillion yuan.
Real estate development climate index
- China’s real estate development climate index reached 93.78, a new low since the start of the COVID-19 pandemic in 2020.
Aug. 15
In analyzing China’s property sector and financial sector risks, Bloomberg Economics wrote, “The big danger is that a negative feedback loop kicks in, with property stress causing strains in the financial system, undermining credit expansion and depressing growth, which, in turn, exacerbates the slump in the property sector.”
Aug. 16
Bloomberg News reported local property agents as saying that existing-home prices have dropped at least 15 percent in the prime neighborhoods of major cities like Shenzhen and Shanghai, as well as in over half of China’s second and third-tier cities.
Prices of existing homes in Hangzhou near Alibaba’s headquarters were down 25 percent to 28 percent from a peak around October 2021, while prices in Shanghai’s Lianyang (an area popular with expats and financiers) fell 15 percent to 20 percent from record highs in mid-2021.
Aug. 17
Bloomberg reported that 18 out of 38 state-owned enterprise builders listed in Hong Kong and the mainland announced preliminary losses in the first six months of the year, up from 11 that warned of full-year losses in 2022. This is compared with just four firms with controlling or major state shareholdings reporting losses in 2021.
Evergrande files for bankruptcy protection
Aug. 17
China Evergrande filed for Chapter 15 bankruptcy protection with the Manhattan bankruptcy court. Evergrande affiliate Tianji Holdings and its subsidiary Scenery Journey also filed for Chapter 15 protection at the same court.
Chapter 15 bankruptcy protection allows a U.S. bankruptcy court to intervene in cross-border insolvency cases involving foreign firms that are undergoing restructuring from creditors. Chapter 15 aims to protect debtor companies’ assets and facilitate the rescue of businesses that are in financial trouble.
Evergrande also issued a separate statement on Aug. 18 asking the U.S. court for “recognition of the schemes of arrangement under the offshore debt restructuring for Hong Kong and the British Virgin Islands.” The statement added, “The application is a normal procedure for the offshore debt restructuring and does not involve bankruptcy petition.”
Zhongzhi’s woes spark fears of ‘Lehman moment’
Aug. 16
Bloomberg reported that Zhongzhi Enterprise Group hired KPMG in late July to review its balance sheet as it faced a worsening liquidity crunch, citing people who asked not to be identified given the privacy of the matter. The sources said that Zhongzhi plans to restructure debt and sell assets after the KPMG review in order to repay investors.
Zhongzhi manages over 1 trillion yuan of assets. The sources said that it was not immediately clear how many products Zhongzhi had defaulted on and whether the firm has enough assets to cover the shortfall if liquidated, and that any restructuring process will likely be drawn out. They added that Zhongzhi has suspended payments on virtually all its products.
Aug. 18
The Wall Street Journal reported that Zhongzhi’s troubles have sparked concern among investors of financial contagion in China and debate over whether a “Lehman moment” could happen in the mainland.
Shadow banking crisis
Aug. 18
Bloomberg reported that China’s property sector problems have created liquidity problems for trusts like Zhongrong, which rely on investments and loans to pay depositors.
Bloomberg Economics estimated that 10 percent of all trust assets (about $300 billion) in China are tied to the property sector. Citing Use Trust, Bloomberg noted that about 106 trust products worth 44 billion yuan have defaulted this year through July 31, while real estate investments make up 74 percent of the defaults by value.
Local debt crisis
Aug. 11
1. Bloomberg reported that Beijing will allow provincial-level governments to raise about 1 trillion yuan via bond sales to pay off local government financing vehicle (LGFV) debt and other off-balance sheet issuers. People familiar with the matter said that the Ministry of Finance has informed the relevant authorities about the “refinancing bonds” program but did not go into detail about the quota set for each region.
The sources said that with the exception of Beijing, Shanghai, Guangdong, and Tibet, all provincial-level governments will be able to use the bonds to repay off-balance sheet liabilities (implicit or hidden debt). Also, the authorities have identified 12 provinces and cities as “high-risk” areas, including Guizhou, Hunan, Jilin, Anhui, and Tianjin, where more support will be provided. Bloomberg added that the bond program will “in effect bail out weaker issuers including LGFVs, shifting the debt burden to provincial governments instead.”
2. Financial Times reported that the State Council is sending teams to more than 10 of the financially weakest provinces to examine their books, including the liabilities of off-balance sheet entities, to search for ways to reduce their debts. Two people familiar with the matter said that working groups with the People’s Bank of China, the Ministry of Finance, and China Securities Regulatory Commission are involved in the debt resolution effort and will report to premier Li Qiang.
The people familiar with the matter said that one of the most crucial tasks of the debt resolution effort would be to review and categorize LGFV implicit debt. The initiative could see some of this debt be swapped to official local government debts while the rest would be restructured. However, a person close to the finance ministry said, “Debt swap programs won’t resolve the root problem as highly leveraged local governments may still have trouble paying off their debt going forward. Much slower future economic growth will undermine fiscal revenue, which is a major source of debt repayment.”
A source close to the finance ministry said that one of the options was to allow local authorities to repay relatively high-interest LGFV debt using some low-interest special purpose and other bonds. The working groups will also get commercial and policy banks to extend maturity loans to LGFVs to ultra-long terms and cut interest rates.
The people said that one of the biggest disputes between the central and local authorities is who should pay off the debt. Beijing wants the provinces to sell assets to make debt payments but local officials say that many assets are illiquid and that the central government must help more with the rescues. The people add that the working groups may continue pressing local governments to sell assets to make debt repayments and adhere to the principle of no direct central government bailouts to avoid moral hazards.
The Times cited Goldman Sachs as estimating total local government debt, including the liabilities of LGFVs, at 94 trillion yuan.
Our take
1. Evergrande’s continued woes are a sign that China’s property bubble is bursting and the debt crisis is steadily worsening. As the Chinese economy deteriorates further, the real estate sector may find it difficult to avert a “hard landing.”
The Evergrande crisis kicked off in September 2021 when it missed bond repayments and later defaulted in December of that year. Given Evergrande’s “too big to fail” status, the CCP authorities used administrative means to help the developer avoid bankruptcy, stem financial contagion, and mitigate the serious social problems that would result from an immediate collapse.
Evergrande would spend the next one and a half years negotiating its debt restructuring with creditors. According to various media reports, Evergrande proposed three solutions, namely, issue new debt to creditors with extended maturity of between five to nine years; offer debt for equity swaps to creditors; or have Tianji Holdings and Scenery Journey issue new debt to creditors in a more complicated rollover scheme. All three solutions would Evergrande delaying principal payment by several years.
Evergrande filing for bankruptcy protection in the U.S. suggests that the developer is almost at the end of its restructuring process after negotiating with creditors. Chapter 15 will shield Evergrande from creditors who are hoping to sue it or tie up their assets in the United States. The protection will also see U.S. creditors receiving compensation in the same proportion as those on the mainland, and enable Evergrande to better integrate its global assets and complete its debt restructuring negotiations with creditors.
The development of Evergrande and the property sector’s debt crisis to this point affirms our analysis over the past few years:
- August 2020: In analyzing the central authorities’ rollout of the “three red lines,” we wrote that “the CCP’s de-risking measures will likely exacerbate its financial risks and trigger serious financial problems, including the bursting of the property bubble.” Also, “Should the CCP’s derisking policies burst the property bubble, the scale of non-performing loans will go up sharply. In this scenario, China will not only see economic Gray Rhinos, but political Black Swans.”
- September 2021: In analyzing the start of Evergrande’s debt crisis, we wrote that “the CCP can hardly allow ‘too-big-to-fail’ Evergrande to simply default and declare bankruptcy” and would likely “look to buy as much time as possible for Evergrande to resolve its debt issues while staving off a default and minimizing financial contagion.”
- October 2021: We wrote that the CCP authorities could “cope with the Evergrande crisis using administrative measures,” but the developer’s troubles “could yet expand and escalate risks of financial contagion.” We also noted that “Xi Jinping’s approach to the Evergrande crisis is a double-edged sword” and the “inability to control financial contagion and a triggering of China’s debt crisis would also sharply raise Xi’s personal political risks.”
With Country Garden’s problems increasingly bubbling to the surface and the property sector in general headed for a crash amid deepening economic malaise in China, Evergrande will increasingly struggle to stay afloat and retain asset value even if it does reach an agreeable debt restructuring plan with its creditors. Eventually, those creditors could put pressure on Evergrande to declare bankruptcy and liquidate. And if Evergrande goes under, it could trigger a wave of developer defaults and bankruptcies, to the detriment of financial institutions (including trust funds like Zhongzhi) with sizable investments in the real estate sector.
2. Concerns about the trouble with Zhongzhi and leading developers Evergrande and Country Garden being potentially a “Lehman moment” for China are not unwarranted.
For one, there are some loose parallels between China’s debt crisis and the U.S. subprime mortgage crisis. Lehman Brothers filed for bankruptcy about two years after the U.S. housing bubble peaked in 2006. Similarly, housing prices appear to have peaked in China in 2021 and are now clearly in decline, while the two leading Chinese developers have either defaulted or are at risk of defaulting.
Meanwhile, contagion from the struggling property sector is impacting the trust industry. Data from the China Trustee Association shows that trust funds in China had the equivalent of about $155 billion in exposure to the property sector at the end of the first quarter in 2023. In particular, Zhongrong Enterprise Group had 18 percent of its assets in the real estate sector in 2020, up from 6.61 percent in 2017; the figure came down to around 11 percent by 2022. As trust funds increasingly become affected by the property sector slump, the risk of contagion spreading to the financial markets, where trust funds have much larger exposure, grows greater.
3. Beijing would certainly be troubled by the debt risks of China’s trust industry, which had about 21 trillion yuan in total assets under management at the end of March 31. But even more troubling to Beijing is the scale of local government (estimated at 94 trillion yuan) and its associated risks.
The State Council’s sending of working groups to the provinces to assess local government debt problems is almost certainly a response to some local governments going public about their debt and financial difficulties earlier in the year (see here and here). By dispatching those teams, the Xi leadership is likely looking to stop more local governments from going public about their debt and financial troubles and get a better handle on debt woes in the provinces, with the goal of preventing the issue from developing into a serious political crisis.
In the short term, however, Beijing is likely limited to administrative means like extending ultra-long term maturity loans to LGFVs and cutting interest rates. As detailed in the Financial Times piece, local governments cannot simply sell assets to make debt payments and require bailouts from the central authorities. And as the Chinese economy and the property sector debt crisis worsen, local governments will generate increasingly less fiscal revenue (especially from land sales) and will struggle even more to make repayments. Meanwhile, the size of local government debt will continue ballooning; local governments need to find 4.7 trillion yuan each year to pay off interest (assuming a conservative interest rate of 5 percent) on 94 trillion yuan of total debt. The situation with local government debt becomes bleaker considering that the poorer provinces have significantly less ability to service their debt as compared to China’s wealthier regions.
